Criminal complaint against company, CA & directors for tax evasion dismissed

Criminal complaint against company, CA directors for tax evasion u/s 276C  by way of bogus share valuation report dismissed

ABCAUS Case Law Citation:
ABCAUS 3754 (2023) (05) AC

Important Case Laws relied upon:
Solar Paper Mills Limited and Ors. vs. The State 
Prakash Nath Khanna & Ors vs. Commissioner of Income Tax
M/s Forzza Projects Private Limited & Others v. PCIT & Another
Kewalchand M. Kothari v. Deputy Commissioner ofIncome Tax,
M/s Vyalikaval House Building Cooperative Society Limited and Others vs. The Income Tax Department (2019) 267 Taxman 81
Tamil Nadu Housing Board vs. Collector of Central Excise
Aban Lloyd Chiles Offshore Limited and Ors. v. Commissioner of Customs  
Prem Dass vs. Income Tax Officer (1999) 5 SCC 241

Income Tax Prosecution

In the instant case a complaint u/s 200 Cr.P.C was filed by Income Tax Officer (ITO) before the Court of Additional Chief Metropolitan Magistrate (ACCM) alleging commission of offence u/s 276C(1)/277/277A/278/278B of the Income Tax Act, 1961 (the Act) and 120B IPC.

The case of the Department was that the accused company had issued shares at premium to co-founder and others at a very high price and received share application money. It was alleged that despite the fact that company was incurring losses for five years, the independent valuer in collusion with the company and its directors prepared a bogus valuation report showing a very high fair value of each share whereas the net worth of the company was in the negative.

It was also alleged that the auditor of the company did not point out this illegality and signed on the financial accounts of company only to help it in perpetrating this   alleged fraud.    

As per the complainant, the entire aggregate amount received from the sale of these shares was to be treated as income/revenue of the company in terms of section 56(2)(viib) of the Act, and not as capital.

It was alleged that all the accused persons including the MD & CEO, director, CA firm/CA Partner involved in valuation of shares and independent statutory auditor conspired with each other.

The Hon’ble ACCM observed that the Hon’ble Supreme Court interpreting section 276C of the Act, held that willful attempt to evade any tax, penalty or interest chargeable or imposable under the Act under Section 276C is a positive act on the part of the accused which is required to be proved to bring home the charge against the accused. Similarly, a statement made by a person in any verification under the Act can be an offence under Section 277 if the person making the same either knew or believe the same to be false or does not believe to be true. Necessary mens rea, therefore, is required to be established by the prosecution to attract the provisions of Section 277.

Similarly, the High Court of Karnataka had elaborated on the scope and ambit of section 276C of the Act in by observing that what is made punishable under this Section is an “attempt to evade tax penalty or interest” and not the actual evasion of tax. ‘Attempt’ is nowhere defined in the Act or in the Indian Penal Code. In legal echelons ‘attempt’ is understood as a “movement towards the commission of the intended crime”. It is doing “something in the direction of commission of offence”. Viewed in that sense, in order to render the accused guilty of “attempt to evade tax” it must be shown that he has done some positive act with an intention to evade tax.

The ACCM opined that in view of the above, a positive action or movement towards the intended crime by the accused has to be pleaded and proved in order to substantiate the allegations of wilful attempt to evade tax etc.

The Hon’ble ACCM further observed that the apex court eloquently explained the difference between evasion and mere failure by observing that when the law requires an intention to evade payment of duty then it is not mere failure to pay duty, It must be something more.  That is, the assessee must be aware that the duty was leviable and it must deliberately avoid paying it. The word ‘evade’ in the context means defeating the provision of law of paying duty. It is made more stringent by use of the word ‘intent’. In other words the assessee must deliberately avoid payment of duty which is payable in accordance with law.

Further it was noted by the Court that the Hon’ble Supreme Court held that the word wilful clearly spells out that there has to be an intention.

Similarly, the Madras High Court making observation about the explanation contained in section 276C of the Act held that the explanation further makes it clear that if any of the circumstances narrated in the explanation is unearthed or made by the accused then such conduct certainly will fall within the ambit of willful attempt to evade any tax or penalty. The fact remains that in the returns filed by the accused, there was no suppression off acts.

Again, Section 276C(2) of the Act was interpreted by the Madras High Court that to punish the accused, there must be wilful attempt to evade payment of tax, he must be in possession of the book with false entries, the person should have made false entries in the book of accounts and omitting any entryin the statement of accounts. The petitioner voluntarily disclosed the undisclosed income to the respondent on   the inspection conducted under Section 132. Therefore, there was no intention from the petitioner for willful evading of payment of tax.

The ACCM opined that the explanation contained in section 276C of the Act is inclusive and not exhaustive but the same gives an insight into the intention of the legislature.

With respect to the argument that at this stage of proceedings, the culpable mental state of the accused is to be presumed in terms of section 278E of the Act, the Court noted that this argument has been comprehensively dealt with in the judgment rendered by Kerala High Court.

The Hon’ble High Court held that a ‘culpable mental state’ which can be presumed under Section 278E of the Act would come into play only in a prosecution for any   offence under the Act, when the said offence requires a ‘culpable mental state’ on the part of the accused. Section 278E of the Act is really a Rule of Evidence regarding existence of mens rea by drawing a presumption though rebuttable. That does not mean that the presumption would stand applied even in a case wherein the basic requirements constituting the offence are not disclosed. The presumption can be applied only when the basic ingredient which would constitute any offence under the Act is disclosed. Then only the rule of evidence under Section 278E of the Act   regarding rebuttable presumption as to existence of culpable mental state on the part of accused would come into play. The expression “failure” used in Section 276CC of the Act is with respect to submission of assessment and return and the same cannot be equated with any failure to pay the tax in time and the liability under Section 276C of the Act. A mere failure to pay the amount due (tax, interest or penalty) will not satisfy the requirement which would constitute the offence under Section 276C(2)of the Income Tax Act.

The ACCM stated that Section 276C(1) of the Act talks of Wilful attempt to evade tax. Firstly, there was no attempt to evade tax, it was not the case of the complainant that accused company did not disclose the factum of allotment of shares at   premium in its accounts or financial statements. It was also not the case of the complainant that there was any wrong entry in the books of accounts, balance sheet and income tax return. The wilful attempt should be any of the acts or situations as mentioned in explanation contained in section 276Cof the Act or any similar act. No actus reus was attributable to the accused company. If upon survey, the complainant wanted to treat a capital receipt as revenue receipt, it is free to do so and it may pass an assessment order making additions to income of the company for the relevant financial year and issuing a notice of demand.

The ACCM observed that all the information that the complainant was relying upon was supplied by the accused company. All the information was disclosed in the books of accounts. There may be different points of view on what is to be treated as an item of revenue and what is to be treated as capital receipt but it does not amount to wilful attempt to evade tax. Even a tax exemption wrongly claimed under a bona   fide belief would not make section 276C of the Act applicable to assessee.

Further the ACCM noted that as per Section 56(2)(viib) the fair market value of the shares shall be higher of value determined in accordance with prescribed method or value substantiated by the company to the satisfaction of Assessing Officer. The complainant had not disclosed the prescribed method and even the fair market value as per the prescribed method. Similarly, no value had been ascribed to shares of company. Therefore, the fair marketvalue of shares of the accused company could not be determined. Once the fair market value can not be determined, then it is also not determinable as to whether the aggregate consideration exceeding the face value of share exceeds the fair market value of shares or not. In the absence of aforementioned calculations, it would be impermissible to add any amount to the income of the company.

The ACCM opined that in absence of the aforementioned computation, there was no   way to consider monies received towards capital as sum received as revenue for a financial year.

The ACCM next considered the plea that the company was incurring loses for past several years. It was contended that based on Net Asset Value method, the fair market value of the shares of the company was NIL. The complainant placed on record copy of Technical Guide on Share Valuation issued by The Institute of Chartered Accountants of India (ICAI). It was noted that as per the guide, Discounted Cash Flow method (used in the valuation report) was described as most commonly   used valuation technique and widely accepted by valuers. It was further mentioned that DCF method is appropriate for valuing start up projects or green field projects as these projects have little or no asset base or earnings which render the net asset   method or multiple approaches inappropriate. 

The ACCM opined that it was correct that the actual cash flows of the accused company did not meet the projections taken into consideration at the time of issuance of valuation report. However, the complainant prepared the cash flow statement of accused company (based on data and information available with complainant and MCA).

The ACCM noted that as per cashflow statement the company’s losses were reducing year by year and from last two years company had cash profits. Further as against the allegation of offloading of shares to co-founder @ Rs.1 per share. The Co-founder in the statement made to the complainant stated that the reason for selling the shares @ Rs.1 per share was negative net worth of the company.   However, after selling the shares, she gave an unsecured loan to the company showing her confidence in the company.

The ACCM opined that one of the best methods to value a startup is DCF method as other methods which take income, assets or net worth as basis for valuation of a business are bound to give negative value of business as none of these methods are forward looking and initially most startups incur losses because most businesses have a gestation period. It is not out of place to mention that the most famed internet based platforms like Amazon India, Flipkart, Zomato, Big Bazaar and Byju’s etc. are all incurring massive loses year after year and yet their shares are being subscribed to by all private equity investors valuing these platforms at tens of thousands of crores.

The ACCM observed that seen in the above context coupled with the fact that the   accused company had started making profit and was generating cash from operations, the valuation of equity shares given by the valuer as per DCF method does not seem to be lofty at all and it certainly could not be termed as bogus. As regards there being difference between the projections of cash flow and actual figures, this was to be expected as it is extremely difficult to predict the future. As no none had predicted the onset of COVID in 2020 or entry of Reliance Jio in Telecommarket, five years prior to occurrence of these events. These two events impacted the reach, penetration and consumption of Internet Data by telecom users   which should have affected operations of the company which was an online news company but no amount of farsightedness could have accounted for these events.  

With respect to the allegation that the Valuer did not do adequate market research before issuing valuation report. The ACCM observed that the accused company was an alternate news media platform which as claimed by it, did not accept advertisement (the biggest source of revenue for other media outlets) and relies upon subscription amounts from members as primary source of revenue. It was not even known that any other alternate media company with such unique business model even exists in India. To its credit, the report stated that it did take into account the information available in public domain. The report also fairly disclosed that it is based upon the figures provided by the management of the company. It also gave the limitations of the valuation report. The valuation report discussed different approaches of valuation and then computed the equity value.

The ACCM opined that since the valuation report was found to be genuine and generally complaint with extant guidelines, there were no material irregularities in the valuation report, so there was no question of commission of any offence by the company, its directors or valuers   engaged by it or its statutory auditor. No   criminal conspiracy of any kind could be said to had been hatched by the accused persons.

Accordingly, the complaint was dismissed being bereft of merit.

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